How to raise money-smart kids

A while ago, my 3-year-old was at his grandparents' house. At one point, he went through the house turning lights off and scolded his grandmother saying, "Grandma, you're wasting money!" I wonder who he got that from. But on a serious note, how do you raise kids that are good with money?

Making Money Real

Of course, every generation likes to complain about 'kids these days.' But one thing in particular seems to be more of a problem than ever before- that money doesn't seem 'real'. So how do you make money real?

I'm convinced that the best way to teach kids about money is to start introducing it to them young. Let them pay for things at the grocery store. Talk to them about why you make buying decisions. Explain where money comes from.

Giving Your Child an Income

Perhaps the best way to teach kids about money is to give them an opportunity to manage it themselves. Of course, you don't have to hand over your check book and budget and tell them to pay the bills. Rather, give them opportunities to manage their own money. To manage their own money, however, your child needs a source of money, or an income. There are several ways to go about this.

Regular Allowance
A regular allowance is probably the most common way to give your child an income. The advantage of an allowance is that it closely resembles the regular paycheck that they will (hopefully) start getting when they hit the real world. On the other hand, parents may feel that giving a regular allowance teaches their kids to expect 'something for nothing'. Perhaps you can stipulate that they only get their allowance if they do regular chores.

Fee For Service Allowance
But maybe you feel that regular chores are something the child shouldn't need to be paid for. Consider giving them an opportunity to earn money by doing harder tasks that are above and beyond their regular chores. Let them know that they can always make job propositions to earn extra money.

Little Entrepreneurs
Another way for kids to earn money is by setting up their own businesses. Even 5-year-olds can do this with a lemonade stand. Older kids can mow lawns and scoop snow. But encourage your child to think outside the box. Why not retail? Warren Buffet famously sold gum and cola door to door as a kid (and look where he is now). Help them brainstorm things the people need or could use, and see if they can meet that need. Besides the money they'll earn, or not earn, the entrepreneurial spirit that you'll light and the lessons they'll learn will benefit them for the rest of their lives.

Pick Up a Job
Older kids can always pick up a part time job. Even a few hours a week will earn the child enough money to start learning money management skills. For state specific rules on when kids can start working, check out the Department of Labor's website, or talk to any local business.

Guiding Your Child's Decisions

Once they have a source of income, give them suggestions on how to manage it. But remember, you're trying to teach them to manage money- don't manage it for them. Talk them through purchases. Suggest saving some of it. Also teach them of the importance of giving some of their money to good causes. A friend of mine shared a story recently about her son:

My son was so helpful tonight. He helped clean the kitchen and sweep the floors. He also helped me change sheets on all the beds tonight. All this without being asked. That kid is a rock star! I ended up giving him some allowance money for his helpfulness and positive attitude tonight. He tried to give it back, but finally took it. However, he decided he is going to put in a good portion of what he got into the offering plate at church on Sunday. He said he wanted to give God back a portion of what He has blessed him with!

What a great example! There are so many lessons that were taught! Her son learned (or relearned) that money is something you earn. His parents are giving him an opportunity to make his own choices with money. And based on one of his choices, it's obvious that he's learned to be selfless with money. Not to mention being selfless with his time, since he wasn't expecting to be paid when he helped out.

Teaching Through Consequences

Of course, when you give kids the opportunity to manage their money, they will not always make great choices. Sometimes they will make bad choices. This is part of the learning process. And this is why you teach them when they can afford to make mistakes. So let them make mistakes. But also talk them through the consequences of their choices.

Your child may want to spend all her money on one thing. Before she makes the purchase, you might suggest that she reconsider and save some of her money. However, she may ignore your advice and make the purchase anyway. Later, she may want to buy something else, but doesn't have the money to do so. Remind her that this is a consequence of spending her money earlier.

Or perhaps your child has followed your advice and does save a portion of his money. Maybe he saves his money week after week and month after month. Then on a family vacation he finds something memorable that he wants to spend his money on. Once you confirm that this is not going to be an impulse purchase he will regret, point out that he's able to spend this money because he has saved so diligently.

Set Goals To Save Towards

It's useful to have a goal to save towards. This puts the savings in perspective and gives motivation to save. As adults, we save towards goals such as retirement or a new car. Younger kids especially won't be able to think so far ahead, so give them more age appropriate goals to save towards.

Perhaps you can teach them to save up to buy Christmas presents. Many kids will be thrilled to know that the presents they are giving are ones that they personally paid for. This is also a great opportunity to teach selflessness.

You could let them save towards a vacation fund. Let them know several months ahead of your next vacation that you will pay for certain expenses. Any extra is on them. If they end up not saving, as an added bonus, you'll have an opportunity to teach them through natural consequences. And as a not-so-great-bonus, you get to use your creativity to come up with free activities to fill your vacation!

College savings is another goal you can have your child save towards. If you are not planning on paying for their higher education, talk to them about the possibility. Of course, this is only something that they will really start rationally thinking about when they get older, so you may decide to make some executive decisions when they are younger and save for them.

And of course, if your kid spots a big ticket item that they just really really need to have, point out that they can save up for it.

Moving Beyond Cash-only

At some point, kids need to learn money that isn't 'real' is still real. In other words, they need to learn that non-tangible money is just important as the cash they can hold. A good place to start is by setting up a savings account for your child. And you may already have one set up, which is great! Let them see the monthly statements to show them how their balance is growing as they sock away money. Take them with you to the bank whenever you deposit or withdraw money, so they can see the exchange of physical cash.

Once you think they are ready, set them up with a checking account and debit card as well. Teach them how to record the transactions in a check registry, either on an excel sheet or in the registry provided. Point out that each purchase reduces the balance in the bank. Talk to them about things like overdraft fees and other fees that banks might charge.

Once your child has a firm grasp on banking and debit cards, you should at least introduce them to the concept of credit cards. Regardless of whether you personally use credit cards or think credit cards are good or bad, as soon as your child reaches adulthood, and especially if your child goes to college, he or she will be bombarded by credit card offers. These offers will come with some juicy perks, and I can guarantee that your child will at least be tempted to open a credit card.

If your child has not been introduced to credit cards and taught the right way to use them, they will likely make classic mistakes such as purchasing too much on the credit card and not being able to pay their bill in full, incurring interest. Or worse, not even being able to pay the minimum, incurring interest and fees, also while destroying their credit. For a great resource geared towards kids headed for college, check out this student credit card guide.

Teaching About Money Earning Money

As you teach your child about their bank account, point out the interest they are earning. Explain that the more they have in the bank account, the more interest they earn. Unfortunately, interest rates are so low currently that the best you'll be able to find is 1%, so the interest earned isn't going to be a very exciting amount. Nonetheless, it gets them thinking about the concept.

This may sound crazy, but I'm convinced you should also teach children about investments. A great place to start is with US savings bonds or with CDs from your bank. These will yield a little more than a savings account and don't fluctuate in value like many other investments. US savings bonds also grow tax-free. Again, explain that their investment is earning them money just for being there.

The Stock Market?!?!
As your children get older, you can introduce them to the larger world of investing! Yes, you can open custodial investment accounts for your kids (do read this article on the implications of opening a custodial account). You can even start retirement accounts for your kids that are earning their own income (you are only allowed to contribute earned income).

Do tread carefully here- you can get burned in the stock market if you don't treat it with respect. Start small. Explain that they should only invest money that they don't plan on touching for a decade or more. Explain that the value of their investment will fluctuate. At times their account balance may be lower than the total amount they've invested. This can be disconcerting, but explain that dips in the stock market happen (sometimes huge, multi-year, dips), but that their investment will rebound, as long as they don't pull their money out. This is why it's a bad idea to obsessively check your investment balance- the current balance is irrelevant as long as you're in for the long haul.

Why, Why, Why, Why, Why???
So given all the risks, why get your kids involved in the stock market at all? Because it's simply the best way to keep ahead of inflation. Cash (both physical and in bank accounts), will see its value gradually eroded by inflation. So any long-term savings should be parked at least in long-term bonds, but better yet in the stocks.

Although it sounds crazy, starting your child in a retirement fund as soon as they start earning income is one of the best things you can do for them. Contributing regularly instills a great habit, and by starting early, you allow compound interest to do its job for that much longer.

Remember tho, the money that they put in the retirement account can not be taken out until they are 59 (my kid's going to be 59 one day!?) without facing serious tax penalties. So any investments that they will want to withdraw prior to retirement needs to be invested in a regular account. Your kid might actually enjoy starting an investment fund dedicated to generating passive income from the dividends. Yes, you may be setting your kid up to be a money nerd.

But How Should They Invest?
There are thousands of brokers, and hundreds of thousands of possible investments out there. So where and how should you start them on investing? If you are up for DIY investing, I always will recommend investing in a Vanguard index mutual fund (and no, I do not get paid a dime for all my Vanguard recommendations). As a recap- an index mutual fund is a 'basket' of stocks that is designed to closely follow a section of the stock market. I recommend a mutual fund because it shields you from losing all your money in one or a few stocks going belly up. I recommend an index fund because it shields you from a fund manager's bad decisions. And I recommend Vanguard because they have the lowest expense ratios (~0.1%).

If you aren't up for investing on your own, don't be afraid to go to a local financial adviser. Two things, however. Make sure that they sign a fiduciary agreement. This was set to be a legal requirement of them, but it looks like that rule is getting scrapped. A fiduciary agreement basically states that your adviser is acting in your (and your kid's) best interests. Secondly, while their fees/expense ratios will naturally be higher (they need to put bread on the table too), if the annual total of fees and expense ratios is much higher than 2%, hold up a red card. Carl Richards has much more on what makes a great financial adviser.

If you set up a custodial account at Vanguard decide whether it will be a retirement account or traditional account. Once it is set up, make sure it is linked to your child's checking account so that you can actually invest. You'll get to pick what funds you want to invest in. If you're investing for your child's retirement (still sounds strange), opt for their Total Market Fund. If this isn't a retirement account and your kid is crazy about starting a passive income (after all, who doesn't want to earn money while they sleep), opt for their Dividend Appreciation Fund.

Teaching Your Child To Budget

Most kids don't have regularly occurring expenses, or any necessary expenses at all, which is the main reason most people need a budget. So how do you introduce them to budgeting? I suggest one of three ways.

1. Play Games
Play games that simulate life and financial decisions. Cash Crunch Games has some interesting games along these lines. Or you could make your own!

2. Talk About Your Budget
As far as you are comfortable doing so, and within a scope that is age appropriate, explain your budget to your kids. At a younger age, you might just want to explain that everything you pay for comes out of the limited amount you earn. As your kids get older, you can share more details if you like.

3. Give Them Expenses
This goes back to the concept of giving kids hands on experience. This also requires a little bit of courage. But giving them a handful of expenses that they need to cover can be a great way to teach them to budget. Presumably, you would also increase their allowance accordingly. So when you give them their allowance, explain that a portion is supposed to cover the designated expenses. Obviously, you'd start with less significant expenses- you don't want to find yourself without electricity and water because your 9-year-old came up short on the utility bill. But expecting them to buy their own clothes and school supplies may be much more reasonable, with more moderate consequences. And maybe one day you will find yourself trusting them enough to let them handle all your bills! Just don't blame me when they buy a shiny red sports car instead.

Radical? Yes! Bad Idea? You Decide.
I realize that a lot of my suggestions may take you and your kids out of your comfort zone. After all, managing money is a big responsibility. But what better reason to start teaching them that responsibility now? Why let them wait until 25 to figure out what #adulting is?

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